The Financial Statements
Chapter 1
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Learning Objective 1
Use accounting vocabulary
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The Language of Business
• Accounting is an information system
 Measures business activities
 Processes data into reports
 Communicates results to people and
organizations
• Accounting is used to make decisions
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Users of Accounting
Individuals
Taxing
Authorities
Investors
&
Creditors
Nonprofit
Organizations
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Financial and Management
Accounting
FINANCIAL
• Provides
information for
external users:
 Investors
 Bankers
 Government
agencies
MANAGEMENT
• Provides
information for
internal users:
 Managers of the
company
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Ethics in Accounting
• U.S. companies are required to report
relevant and reliable information
• Recent corporate scandals have emphasized
the need for ethical reporting in accounting
• Companies that sell stock to the public must
have an audit by independent accountants
 Examination of financial records to ensure
reliability
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Forms of Business Organization
Proprietorship
Partnership
Corporation
LimitedLiability
Company
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Proprietorship
• Business has a single owner
• Legally, business is not separate from
owner
 Owner is personally liable for business debts
• For accounting, business records are kept
separate from personal records
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Partnership
• Two or more owners
• Each partner is personally liable for
business debts
 Can be risky
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Limited Liability Companies (LLCs)
• Owners are called members
• Members are not personally liable for
business debts
 Reduces owners’ risk
• Today, many non-corporate businesses
form as LLCs
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Corporations
• Owners are stockholders
 Stockholders elect Board of Directors
• Board sets policy and appoint officers
 Stockholders not personally liable for
corporate debts
• Formed under state law
 Pay income taxes
• Legally distinct from owners
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E1-13
• a. What forms of organization will enable
the owners of Quality Environmental to
limit their risk of loss to the amount they
have invested in the business?
• Corporations and Limited Liability
Companies (LLC)
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E1-13
• b. What form of business organization will
give Beard the most freedom to manage
the business as she wishes?
The owner
wouldn’t have
to worry about
other owners
• ______________________
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E1-13
• c. What form of organization will give
creditors the maximum protection in the
event that Quality Environmental fails and
cannot pay its debts?
• Hint: Think about liability and number of
owners
• Answer: Partnership
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Learning Objective 2
Learn accounting concepts and principles
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GAAP
• GAAP is an acronym for Generally Accepted
Accounting Principles
• U.S. GAAP is formulated by the Financial
Accounting Standards Board (FASB)
• FASB’s Conceptual Framework states that
accounting should be:




Relevant
Reliable
Comparable
Consistent
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Accounting Concepts
• Entity
 A business is separate from its owners
• Reliability
 Accounting is based on objective evidence
• Cost
 Assets are recorded at cost (not fair value)
• Going-Concern
 Business will continue indefinitely
• Monetary Unit
 Transactions are recorded in a stable currency ($)
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Concept Violated?
• Kathy Jones owns a coffee shop. Her
personal expenses are included in the
accounting records.
• Entity
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Concept Violated?
• ABC Company owns land. The purchase
price is $50,000. A recent appraisal
indicates the land is worth $200,000.
• ABC shows the land in its financial
Which concept
statements at $200,000.
deals with the how
assets are valued?
• ________________________
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Learning Objective 3
Apply the accounting equation to
organizations
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The Accounting Equation
Liabilities
=
+
Owners’
Equity
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Assets
• Economic resources that provide a future
benefit
• Examples:





Cash
Inventory
Equipment
Land
Buildings
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Liabilities
• Outsiders claims to assets
 Include debts payable to creditors
• Examples:
 Accounts payable – liability for goods or
services purchased on credit
 Notes payable – written promise to pay on a
certain date (bank loan)
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Owners’ Equity
• Owners’ claim on a business
• Assets minus liabilities
 What’s left after debts are paid
• A corporation’s equity is called
stockholders’ equity
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Accounting Equation Example
• Compute the missing amount from each
situation on the following slide
• Remember:
 Assets = Liabilities + Owners’ Equity
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Accounting Equation Example
Assets =
Liabilities +
Owners’ Equity
(a)
$70,000
$50,000
$20,000
(b)
$30,000
$20,000
$10,000
(c)
$40,000
$15,000
$25,000
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Shareholders’ Equity
• Paid-in capital
• Retained Earnings
• Amounts invested by
stockholders
• Common stock
• Amounts earned and
kept for use in the
company
• Increased by
Revenues
• Decreased by
Expenses
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Net Income
• Revenues
 Earned by delivering goods or services
• Expenses
 Costs of doing business
 Rent, utilities, insurance
• Revenues minus expenses equal net
income
 If expense are greater then revenues, a net
loss occurs
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Dividends
• Distributions of assets (usually cash) to
shareholders
• Decrease Retained Earnings
• Do NOT impact net income
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Revenues
minus
Expenses
Beginning
Retained
Earnings
plus
Net
Income
minus
Equals
Dividends
Ending
Retained
Earnings
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Learning Objective 4
Evaluate business operations
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The Financial Statements
• Report company’s results to the public
• Four Statements




Income Statement
Statement of Retained Earnings
Balance Sheet
Statement of Cash Flows
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The Income Statement
• Measures operating performance for the
period
• Reports revenue and expenses and
resulting net income (or loss)
• Also includes gains and losses
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Statement of Retained Earnings
• Shows increases and decreases to
retained earnings
• Increase: net income
• Decrease: dividends
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Balance Sheet
• Measures financial position
• Reports assets, liabilities and
shareholders’ equity
• Assets and liabilities are categorized
 Current and Long-term
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Balance Sheet Categories
• Current assets
 Converted to cash or used within one year
 Cash, Short-term Investments, Accounts
Receivable, Inventory
• Long-term




Property, plant, and equipment
Intangible assets
Investments
Other
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Balance Sheet Categories
• Current liabilities
 Due within one year of balance sheet date
 Accounts payable, salaries payable, taxes
payable, short-term borrowings
• Long-term liabilities
 Long-term notes payable, mortgage payable
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Balance Sheet Categories
• Stockholders’ Equity
 Paid-in capital
• Common stock
 Retained Earnings
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Statement of Cash Flows
• Shows inflows and outflows of cash by
category:
 Operating activities
 Investing activities
 Financing activities
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Cash Flow Categories
• Operating
 Cash generated from day-to-day business
activities
 Related to selling goods and services to
customers
• Investing
 Cash invested in long-term assets
 Related to purchasing and selling plant assets
and investments
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Cash Flow Categories
• Financing
 How a company obtains resources to finance
business
 Related to long-term debt and equity (issuing
stock)
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Learning Objective 5
Use financial statements
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Relationships of Financial
Statements
• Net Income (bottom line of Income
Statement) flows to Statement of Retained
Earnings
• Ending Retained Earnings flows to
Balance Sheet
• Cash balance from Balance Sheet flows
Statement of Cash Flows
Financial Statements should be prepared in
order since the amount on one statement flows
the next
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INCOME STATEMENT
NET
INCOME
RETAINED EARNINGS
STATEMENT
ENDING
RETAINED
EARNINGS
BALANCE SHEET
ENDING
CASH
STATEMENT OF
CASH FLOWS
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E1-19
• a) Common stock
 Balance Sheet
• b) Income tax payable
 Balance Sheet
• c) Dividends
 Statement of Retained Earnings
• d) Income tax expense
 Income Statement
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E1-19
• e) Ending balance of Retained Earnings
 Statement of Retained Earnings AND
 Balance Sheet
• f) Total assets
 Balance Sheet
• g) Long-term debt
Which statement reports
liabilities?
 _____________________
• h) Revenue
 Income Statement
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E1-19
• i) Cash spent to acquire the building
 Statement of Cash Flows
• j) Selling, general and administrative
expenses
 Income Statement
• k) Adjustment to reconcile net income to
cash provided by operating activities
 Statement of Cash Flows
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E1-10
• l) Ending cash balance
 Balance Sheet AND
 Statement of Cash Flows
• m) Current liabilities
 Balance Sheet
• n) Net Income
This number is
the bottom line
on one
statement and
is an increase
to another
 __________________________ AND
 ____________________________
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End of Chapter One
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